China growth concerns continue to favour stronger USD

AUD: RBA remains on hold while citing more concern over China slowdown

The biggest mover overnight has been the Australian dollar which has weakened sharply against the US dollar by just over 1% resulting in the AUD/USD rate falling back below the 0.6400-level. The main drivers for the Aussie sell-off overnight has been the RBA’s latest policy update and China growth concerns. The RBA decided to leave the policy rate unchanged at 4.10% for the third consecutive month. It was the last policy meeting before RBA Governor Philip Lowe is replaced by Deputy Governor Michele Bullock on 18^th September. The decision to leave rates on hold again has reinforced market expectations that the RBA has reached the end of their hiking cycle although the update guidance continued to signal that they remain ready to raise rates again if required. The RBA continues to note that “some further tightening may be required… but that will depend on the data and evolving assessment of risks”. The Australian rate market is currently pricing in around 8bps of hikes by the end of this year followed by one 25bps rate cut by the end of next year. The decision to leave rates on hold today was in line with market expectations. The recent data flow including lower than expected inflation print for July has helped to ease pressure on the RBA to hike further.

We are not expecting any shift from the RBA’s current data dependent approach under incoming Governor Bullock who stated recently that monetary policy decisions will be made by considering economic data “month by month”. The RBA’s updated policy statement described recent data as “consistent with inflation returning to the 2-3% target range over the forecast horizon”. Nevertheless, the RBA remains concerned that “services price inflation as been surprisingly persistent overseas and the same could occur in Australia”. In addition, the RBA noted that there also uncertainties regarding lags in the effect of monetary policy and how firms’ pricing decision and wages respond to the slower growth in the economy when the labour market remains tight. Those risks highlight that the RBA has not completely ruled out further hikes despite leaving rates on hold at recent policy meetings.
One area of concern that has attracted more attention in the policy statement is the “increased uncertainty around the outlook for the Chinese economy due to ongoing stresses in the property market”. The loss of growth momentum in China has attracted more market attention as well and has contributed towards a weaker Australian dollar which has resulted in the AUD/USD rate falling to a year to date low last month at 0.6365. The next key support area is provided by the lows from the autumn of 2022 between 0.6200 and 0.6400. Investor sentiment over China is likely to remain the most important driver of Australian dollar performance in the near-term. The recent Aussie sell-off will extend further if stimulus measures being implemented by policymakers in China fail to stabilize/improve investor sentiment through the rest of this year.

CHINA GROWTH CONCERNS HAVE BEEN WEIGHING DOWN ON AUD

Source: Bloomberg, Macrobond & MUFG GMR

EM FX: Weighing up potential impact from China policy stimulus

It has been another tough week for EM FX performance that has seen our MUFG EM FX index fall back towards last month’s year to date lows against the USD. The best performing emerging market currencies over the past week have been the COP (+1.4% vs. USD) and IDR (+0.2%). While the worst performing emerging market currencies have been the ZAR (-3.1% vs. USD), MXN (-2.7%). RUB (-1.6%), BRL (-1.3%) and TRY (-1.1%)     

The price action suggests that market participants are not yet convinced that policy stimulus measures rolled out by policymakers in China will be sufficient to drive a significant improvement in the economic outlook. Domestic policymakers have outlined fresh policy stimulus measures over the past week including: i) lowering interest rates for new and existing mortgages and lowering minimum down payments for mortgage borrowing, ii) increasing personal income tax deductions for child care, parental care and children’s education spending, and iii) local governments bringing forward issuance of special bonds to finance infrastructure investment. The measures are intended to encourage stronger household consumption and stimulate demand especially in the struggling housing market that has been weighing heavily on growth. At the same time, domestic policymakers are continuing to provide more support for the CNY as they step up efforts to prevent a further sell-off as USD/CNY moves closer to last year’s high at 7.3274. The latest policy step was the decision to lower the FX RRR by 2ppts to 4.0%. It sends a clear signal that domestic policymakers do not want a repeat of the period between 2015 and 2016 when CNY weakness contributed to heavy capital outflows. As we saw at the end of last year, if the stimulus measures prove successful in restoring confidence in China’s growth outlook they could provide an important bullish turning point for EM FX.    

Emerging market currencies have also failed to benefit from the scaling back of rate hike expectations for the Fed and other major central banks. The release of softer US employment  data has reinforced expectations that the Fed can pause their hiking cycle while the euro-zone rate market has moved more in line with our view for rates to remain on hold in September as well. The less hawkish shift in the outlook for major central banks has encouraged volatility to drop back in both the rate and FX market. Yet the MXN which is one of the most popular carry trades suffered a setback over the past week after Banxico decided to gradually reduce their FX hedge program starting from this month. Banxico currently has around USD7.5 billion of outstanding positions. The unwinding of the FX forwards signals more unease over MXN strength. Banxico remains reluctant to cut rates this year in light of stronger than expected growth. The GDP forecast for 2023 and 2024 were revised up to 3.0% and 2.1%. The developments have helped to lift USD/MXN back towards last month’s high at 17.428.  Please see our latest EM EMEA Weekly for more details (click here).

KEY RELEASES AND EVENTS

Source: Bloomberg